July 5, 2018
Thinking of switching to a new loan to take advantage of a lower rate, to reduce your repayments, or to take advantage of any of the other benefits of refinancing? The first question a lot of homeowners ask is, how much equity do you need to refinance?
If you haven’t paid down your mortgage enough, refinancing may not be worth it. Find out how much equity you need before you should think about applying for a new loan.
Equity is the amount of ownership you have built up in your home, both through your initial deposit and the repayments you have already made on your mortgage. It is what you have already paid for towards your property.
You can look at equity in relation to your mortgage. It is the portion of your home’s value that you no longer owe. For example, if you fully own your home, you have 100% equity. If your home is worth $500,000 and you still owe $300,000, your equity would be 40%.
If your home increases in value over time, the amount of equity you have will also increase. This is because the amount that you still owe on your loan will not change but the value of the property – and your owned portion of it – increases.
The value of your property minus your outstanding loan amount is your equity.
If the value goes up, your equity goes up. As your outstanding balance goes down as you pay down your mortgage, your equity will go up as well.
On the other hand, your equity will go down if changes in the property market cause your home’s value to drop. This is because the market value for your equity decreases. A drop in value won’t change your mortgage, but it could impact you when you go to refinance your home loan. This is something you should consider before refinancing.
The more equity you have, the more negotiating power you will have when it comes to refinancing. This is because your equity serves as the security for your new home loan. If you have a lot of equity, your bank won’t take on as much risk as they would if you didn’t have much equity – either because you haven’t been paying down your loan for long enough or because the property value changed.
The smaller the amount you owe, the lower the interest rate that you will be able to command, which could save you a lot of money in the long run. Lenders look at the amount of equity you have already built up as a measure of your ability to repay the loan in the future. For the most part, those who have higher equity tend to be more reliable borrowers.
With initial home loans, you can often get a loan with only a 5% deposit. However, in the case of refinancing, you’ll want to have at least 20% in equity, and even more if you are a self-employed borrower.
Although there are some lenders that may be willing to refinance your loan for a lower amount, you will need to pay lender’s mortgage insurance (LMI). In most cases, the added cost of LMI can make refinancing not worth it for you.
In today’s more conservative mortgage environment, you may want to think twice about refinancing right away if you haven’t a lot of equity in your home. With total household debt at 200% of disposable income in Australia, there is still pressure on banks to be careful about handing out new loans.
You may want to wait until you build up more equity by paying down more of your mortgage. By paying down your loan faster with extra repayments, you may be able to reach your equity target a lot faster, making it easier to refinance sooner. You can use a mortgage calculator to see how much quicker you could reduce your outstanding balance at your current interest rate.
Likely your best bet, however, may be to hold off on refinancing until you have built up at least 20% equity. Not only do you want to avoid having to pay LMI again but you also will be able to qualify for a better loan with a lower rate and other attractive features, when you have more equity.
If you are really struggling to make your current mortgage payments and absolutely must refinance to obtain a lower monthly repayment, you could refinance with a guarantor. A guarantor is another person who takes responsibility for repaying the loan if you become unable to meet your repayment obligations. Typically, this is someone like your parents or another close friend or family member.
You may also have better luck with private lenders, who may have less strict rules for mortgage refinancing than major banks. Smaller lenders will be more likely to take the full picture of your unique financial situation into consideration, rather than looking solely at your equity as a measure of your ability to make repayments.
When done at the right time, refinancing could save you a lot of money, or you could use a new loan to help you meet your financial goals, from better budgeting and debt consolidation to investing. But, rushing in to refinance just because rates have gone down a couple of years after you took out your home loan or to try and lower your repayments to get some financial breathing room could backfire if you aren’t in a strong position to refinance.
Compare lenders, compare the numbers, and talk to a mortgage specialist or other financial professional for any questions or guidance you may need.
Written by Refinancing.com.au
Refinancing.com.au is an end-to-end service that helps people refinance their home loan. We empower you to search for your home loan, and choose the process that suits you.
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